Sirius and XM's star-crossed merger

Comment One man's "merger of equals" is another man's "merger of disasters." In the case of XM and Sirius, US regulators need to figure out just what kind of men they are. And nothing less than your rights to, well, sound will hinge on their decision.

It's been 76 days since XM and Sirius filed their merger intentions with the Federal Communications Commission (FCC), and the deal hasn't even passed preliminary review. The FCC is taking longer to examine the estimated $13bn merger than it did with the Time Warner/America Online and BellSouth/AT&T proposals combined. Ignore the FCC, and you find the Department of Justice scratching its head even harder.

The Federal hesitation to face the XM/Satellite tie-up proves understandable. We're talking about a government-created duopoly heading toward a government-sanctioned monopoly. Even Microsoft would salute the anti-trust issues at play.

In order for regulators to work around the obvious anti-trust concerns, they'll need to come up with some creative definitions for what counts as competition in the audible universe.

American Duopoly

On April 1, 1997, the FCC auctioned two licenses to provide Digital Audio Radio Service (DARS) via satellite over the 12.5 MHz spectrum on the condition that the two licensees would never merge.

XM and Sirius - paying about $90m each - won the contracts over Digital Satellite Broadcasting Corp. and Primosphere. The rule governing the victory was clear: no applicant is permitted to own more than one of the two licenses. In issuing the contract and organizing a different market for the companies to exist in, the FCC also established satellite radio as a separate entertainment medium.

Ten years later, XM and Sirius are struggling to survive. The two propose Voltron wisdom; only by combining their powers can they defeat the evil market that has battered and bruised them so.

So, now they want a bailout from the very regulators that crafted this situation in the first place. The FCC created a duopoly to ensure a level of price and service competition, and we're asked to ignore that.

Good Rule Hunting

XM and Sirius have some serious work ahead to ensure their marriage. The FCC is still debating the golden rule of the 1997 DARS agreement before they'll even begin to look at the case. Commission Chairman Kevin Martin said forgetting the rules set when they handed out the licenses will be a "high hurdle" for the companies to overcome.

Sirius CEO Mel Karmazin argues that the DARS anti-merger rule wasn't a "rule" at all, but rather more of a "statement."

"It's a little gray whether there's a rule or there isn't a rule," Karmazin said at a Lehman Bros. investor conference in New York. "If you go to the rule books, I'm not sure you'll find a rule."

Meanwhile, the proposed merger isn't getting any love from Congress either. Chairman of the US antitrust subcommittee, Wisconsin senator Herb Kohl last month asked regulators to block the deal on grounds it would cause "substantial harm to competition and customers."

Karmazin managed to put his rule hunting expedition aside long enough to explain to the House Energy and Commerce Committee why the deal is not, in fact, eliminating any competition. He argued that potential customer ears are constantly barraged by what is satellite radio's greatest rival: Sound.

XM and Sirius share the market not just with each other, but with all other forms of audio. Consider musical alternatives such as terrestrial radio, MP3 players, CDs, internet radio, street musicians, singing gondoliers — an industrious songbird — they all have the potential to steal satellite customers.

If only Rockefeller had the gumption to argue that Standard Oil faced competition from other forms of combustible material such as wood and laptop batteries.

Why a monopoly is good for YOU

But let's assume XM and Sirius have a valid point. How then does a merger save them?

The fine details as to how a Sirius and XM union will eek out a profit remains a mystery. XM and Sirius' lawyers are on such tenterhooks now, they aren't talking. (Both companies declined to comment for this story.) But it probably involves heavy multiplication and maybe even a cosine or two — so let's step back. Like many intractably complicated problems, the logic can be boiled down to a simple equation:

F + F = P

Where:

P = profit and F = sinking ship of a business model.

There's a problem with the above math. Can you spot it?

While both companies have enjoyed steadily expanding revenue each quarter, neither has come up with anything resembling a profit. In their latest earnings reports, XM posted revenue of $264m but still managed to come out $122m in the red. Despite Sirius' $204m revenue, it posted a loss of $145m in the quarter.

While satellite radio revenue increases...

XM and Sirius have spent ridiculous amounts of cash trying to one-up each other with overpriced exclusive celebrities. Sirius payed $500m to ink Howard Stern for 5 years. XM countered with a $55m, 3-year contract with Oprah Winfrey. The spending increased losses at pace, but did precious little to boost revenue at a similar clip.

This deserves its own paragraph: Oprah didn't change anything. Oprah! The woman could bottle SARS and make a profit.

Total income remains in the negatives

Okay, forget the law and finances. What about the customer?

XM and Sirius assure regulators not to worry about price gouging. They propose to submit to regulations that temporarily lock prices to ensure customers won't pay more after the merger than they did before. Forgive us if a temporary ban before price self-regulation doesn't exactly foster the warm fuzzies.

Karmazin tells regulators that the merged companies will be able to sell more advertising. That's good for business, but not for one of the key appeals of "ad-free" satellite radio.

Being able to offer more channels is also a sticky wicket. XM and Sirius already use nearly all their bandwidth available for their current lineup. Some propose an a la carte option as a solution, but this usually leads to dividing content into lumps. Want sports? That's extra. Want comedy? That's a whole different package.

The merger would also impose the costs of new equipment. XM and Sirius use different satellite technologies, allowing units only to receive signals from one parent company.

As the regulators sloth their way toward considering this merger, they need to reach the obvious conclusion. XM and Sirius must fix their own business models separately. These companies don't make corn or even airplanes. They're not deserving of federal aid after abusing a government-created duopoly by over-spending.

There's got to be way to make money in satellite radio without eliminating customer choice and pissing on antitrust regulations.

Then again, if you can mess up with Oprah on your side, maybe it's time to throw in the towel. ®